A mutually exciting rough jump diffusion for financial modelling

Donatien Hainaut ()
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Donatien Hainaut: Université catholique de Louvain, LIDAM/ISBA, Belgium

No 2023011, LIDAM Discussion Papers ISBA from Université catholique de Louvain, Institute of Statistics, Biostatistics and Actuarial Sciences (ISBA)

Abstract: This article introduces a new class of diffusive processes with rough mutually exciting jumps for modelling financial asset return. The novel feature is that the memory of positive and negative jump processes is defined by the product of a dampening factor and a kernel involved in the construction of the rough Brownian motion. The jump processes are nearly unstable because their intensity diverges to +∞ for a brief duration after a shock. We first infer the stability conditions and explore the features of the dampened rough (DR) kernel, which defines a fractional operator, similar to the Riemann-Liouville integral. We next reformulate intensities as infinite dimensional Markov processes. Approximating these processes by discretization and then considering the limit allows us to retrieve the Laplace transform of asset log-return. We show that this transform depends on the solution of a particular fractional integro-differential equation. We also define a family of changes of measure that preserves the features of the process under a risk neutral measure. We next develop an econometric estimation procedure based on the peak over threshold (POT) method. To illustrate this work, we fit the mutually exciting rough jump diffusion to time-series of Bitcoin log-returns and compare the goodness of fit to its non-rough equivalent. Finally, we analyze the influence of roughness on option prices.

Keywords: Self-exciting process; Epidemic Type Aftershock Sequence (ETAS); jump diffusion; fractional Brownian motion; Riemann-Liouville fractional integral (search for similar items in EconPapers)
Pages: 29
Date: 2023-04-05
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